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A Bumpy Ride with Promise

President Barack Obama's assertion in a recent speech that India "is not simply emerging but has emerged" underscores the huge potential the Indian market holds for U.S. and Western multinational companies. In the last 15 years, India has emerged to rival China as one of the world's fastest growing economies, with a burgeoning middle class eager to buy goods and services. Although its northern neighbor outpaces India in large-scale export-focused manufacturing and attracts more foreign investment,

India excels when it comes to its highly educated workforce, democratic institutions and less restrictive operating environment.

However, impediments to doing business in India are formidable, from currency convertibility and potential political instability to rising inflation. Challenges include corruption and graft, although those problems are receding, and a checkered infrastructure of sparkling glass skyscrapers that reflect adjacent slums, and airports and roads that look as if they belong in the 1950s.

From a treasury standpoint, the services like cash management and liquidity management available from large banks in the country have expanded. A secondary relationship with a local bank remains crucial, given the widespread use of cash and paper checks and the slow adoption of credit and debit cards. Although India is fast moving toward electronic payments, it still lags more developed markets in this regard, creating a credit risk for companies that must wait more than a week for checks to clear.

Other obstacles for global treasurers include rupee convertibility, which has improved significantly but is still only partially allowed, and rupee hedging, which remains limited, although at least systems are now in place to permit transactions.

But India has come a long way in a relatively short time. "Twenty years ago, there were hardly any foreign or private banks, technology was nonexistent and the state-owned banks were the leaders," says Tapan Buch, finance director at Procter & Gamble India. "Pretty much everything was manual, collections and payments were via checks or cash, which resulted in long collection lead time and higher security risk. Even the same bank did not have its branches connected, and funds transfer took three to four days. India back then was 20 different countries within one country."

And the situation today? "Given the electronic transfer systems enabled by the [Reserve Bank of India] and the best-in-class clearing infrastructure and technology provided by our partner bank [Citibank], everything is moving towards electronic mode, making things significantly easier," Buch says. "Citibank has developed an automated host-to-host solution for us to enable straight-through processing.

"The government also opened up the banking sector to private banks, which created a sea change in competition and entrepreneurship, resulting in improved customer service," he adds. "However, there are still some challenges that remain, like offshore cash pooling and currency convertibility. But so much has been accomplished."

Indeed, the big threat that scared business away from India in the 1990s--the risk of the government expropriating assets and intellectual property-- has faded. Breakthrough economic reforms began in 1991, as the country migrated from socialism to capitalism, and continue apace, a mix of neoliberal policies governing international trade and investment, tax reforms and promoting deregulation. The Indian government gradually loosened restrictions against foreign-owned sales, services, entry and ownership. The market isn't completely open, of course, but what else would explain Starbucks' recent announcement that it is exploring the possibility of opening outlets in the country? Three years ago, the Seattle-based coffee chain pulled back on its intention to enter the market given uncertainty over government approval. Now that it has inked deals to acquire coffee beans from local producers, the talks are back on track.

Ask U.S. businesspeople about India then and now and the answers suggest two different countries. Fifteen years ago, Neil Schloss, treasurer and corporate vice president at Ford Motor Co., made his first visit to India. "I went there to set up a subsidiary of Ford Credit as a joint venture, and it was pretty archaic from the standpoint of how one conducted business," Schloss says. "There was a tremendous amount of paperwork and bureaucracy. In terms of financial institutions, other than the state-owned banks, I can recall Citibank and Deutsche Bank. They had shingles outside small buildings, and if they had air conditioning, it was an added plus."

Fast forward to India today, and Schloss says, "The quality and capability of the banking industry there has improved substantially. Financial institutions, both local national banks and foreign banks, are very attuned to what is going on in the global market, in terms of providing products and services. While it is still a very regulated business and currency exchange remains a headache because of the paperwork and regulatory approvals, there is the will, capability and intellect to effect change. Compared with China, India will get to a workable regulatory regime faster, although they are not there yet."

Few companies are waiting, however, for the regulatory regime to catch up with modern standards. There's money to be made now. India's gross domestic product expanded 8.4% last year, compared with estimated growth of just 2.9% in the United States. India's GDP growth is expected to remain at current levels through 2015, according to EconomyWatch, which projects that the size of India's economy will surpass that of Germany in 2020 and that of Japan in 2025. Companies that were waiting in the wings to enter India's market are now busy on stage.

"India has a huge population of more than 1 billion people and a rapidly growing middle class that numbers around 300 million," says Mukundan Iyengar, executive director of J.P. Morgan Treasury Services. "Labor is also relatively cheap comparable to other markets, and I mean skilled labor. The talent pool is pretty huge."

These draws first lured large U.S. and Western European multinational corporations and now are attracting midsize and smaller companies, says Manish Antani, vice chair of global services at law firm Barnes & Thornburg, which helps clients minimize the legal and regulatory risks of conducting business in India. "We've seen a substantial increase in the number of all types of different-sized companies in the Indian market, including automotive, pharmaceutical, general business consulting, IT, telecom and the companies that supply these sectors," Antani says.

Others agree the pluses of market entry outweigh the minuses. "When you have 2% to 3% growth in your own market and are looking at a market with 8% to 9% growth, 7% inflation and a rapidly mushrooming middle class with unmet demands, you are going to tap these possibilities," says Varun Bedi, chief investment officer at restructuring firm Tenex Capital Management in New York. "Add it up, and that's 15% without trying too hard." Bedi helps companies acquired by Tenex use Indian offshoring to improve efficiencies.

The "unmet demands" of the middle class are creating some bottlenecks. "Three years back, you could walk into a car dealership, purchase a car and have it in your driveway in a week," says Chintan Shah, director and head of cash management and corporate sales in India for Deutsche Bank. "Now, so many people want cars that the wait for delivery can take three months. The demand has gone up significantly, and not just for cars but for other products and services."

With all that it has going for it as a global marketplace, including a growing middle class, India remains bedeviled by poverty. "One cannot underestimate the country's poverty. It requires foreign companies to alter their products," says Bedi. "For example, you can't sell the same size box of cereal or a large box of Tide detergent since consumers cannot afford it. Rather, you must make much smaller serving sizes."

Other problems include inferior infrastructure and a regulatory system that despite improvements has some catching up to do. "The airports and roads are antiquated, and power generation is an issue," says Larry Harding, president of High Street Partners, an Annapolis, Md., provider of international business services. "If you're setting up an office, you have to be cognizant of a backup power supply."

It can also take a long time to create a legal entity in India, whereas it takes a day in the U.S., says Antani. "You have to file so many papers--to obtain a tax ID, a director ID, pick a name for the entity, and then wait for approval by relevant government agencies. They call it the 'automatic approval' process but there is nothing automatic about it--it can take months and costs a lot of money."

Harding notes the particular burden of filing for a Permanent Account Number (PAN), required by the Indian tax department to limit tax fraud. PANs are mandatory if you want to open a bank account, receive taxable salary or professional fees, and sell or buy assets above specified limits. "A PAN is a way of switching presumed innocence to presumed guilt from a tax standpoint--an administrative exercise that is a real pain in the neck," he says.

Another hitch is real estate costs. "If you're thinking of purchasing or leasing real estate in the large cities, be prepared for expenses on par with New York City," Antani says.

On the bright side, India has created Special Economic Zones--areas that operate under less onerous regulations. "They used to be in city centers, but now they're in the suburbs, which saves money on overhead," Antani says. "Plus, they come with special tax incentive benefits."

The big worry at the moment is inflation, which may be good for growth but raises the specter of political instability. India's benchmark wholesale price inflation rate posted an 8.4% year-over-year gain in December, and while initial estimates were that the rate would subside to 5.5% by March, the Reserve Bank of India now anticipates a 7% rate. Adding to inflation concerns is Egypt's political crisis, which may prompt policymakers to boost interest rates, the bank recently announced.

Fast-rising commodity prices, especially food costs, are a major concern because of their impact on poorer sections of India's population and the political unrest they may foster. Food accounts for 47% of India's consumer price index. In response to inflationary pressures, the Reserve Bank of India has boosted borrowing rates seven times in the past year, and some pundits foresee another 100-basis-point increase by the end of the year. These concerns have caused a 4% decline in the value of the Indian currency, the rupee, against the dollar since November. Indian stocks have also plunged and are down more than 10% so far this year.

While protectionism has decreased in India, some industry sectors like large retail are stymied by regulations that impede market entry and expansion. "Companies like Wal-Mart and Target are restricted from opening stores in India," says J.P. Morgan's Iyengar. "It's a political issue that is driven by the thousands of 'mom and pop' stores in the country."

P&G's Buch concurs, noting that India has 8 million retail outlets or "high-frequency" stores, as they're called in the country. "The biggest challenge from a consumer goods point of view is how to transfer funds seamlessly from the customer to 8 million outlets to the distributor and then on to me," he says. "Our global bank [Citibank] has taken care of the last part--between the distributor and us--but the rest of the conundrum is not yet completely solved."

Tenex Capital's Bedi says foreign investors face barriers in other industries, such as telecom, insurance and airlines, where businesses must be majority-owned and controlled by Indian companies. "Insurance, for instance, is limited to a 26% foreign ownership," he says.

And while foreign banks are now allowed to operate in India, the process is complicated. "The central bank requires you to obtain licenses to build brick-and-mortar branches," Iyengar says. "It's a challenge for every foreign bank, but at least we're all on the same level playing field."

Certainly, the banks aren't letting onerous licensing requirements stand in the way of progress. Large, global banks like Citibank, J.P. Morgan and Deutsche Bank continue to build out their presence, and the days of a shingle outside a small building are long gone. Deutsche Bank, for instance, now has 7,800 employees in India, 15 retail branches in 14 cities and more than 500,000 retail customers in the region. It offers a transaction banking platform with solutions across cash management, trade finance and custodial services. Citibank's services are comparable, and J.P. Morgan is catching up.

Paul Simpson, global head of trade and treasury solutions at Citibank, says another factor explaining India's attraction is its legal framework, which is based on Anglo-Saxon law.

"India has been pretty consistent in being very predictable from a legal standpoint," Simpson explains. "Concerns you might run into in other emerging markets you don't run into in India. We've also seen significant improvements in mobile platforms, Web access and telecom. Mobile platforms, for instance, have added another channel from a wholesale and consumer perspective. Response times on local networks used to be a big problem, with the bandwidth just not there. This has changed dramatically."

While foreign banks continue to provide estimable service to their clients, it is still important for multinationals to work with local banks as well. "You need to have relationships with both a large global bank and a local bank, the former as your cash consolidation and liquidity bank and the latter as your receivables bank," says Simpson.

Despite the presence of these sophisticated bankers in India, treasurers still face problems, chief among them currency convertibility. "With a rupee futures exchange only recently introduced, companies for now still have to rely on a mix of options and forwards, which cost more from an over-the-counter currency standpoint," Bedi explains. "If a company is selling in the Indian market, it can at least convert its indigenous currency into rupees and tap this capital to fund its Indian operations."

Another nagging problem from a treasury standpoint is the slow growth of electronic payments. "In India in 2003, over 80% of all non-cash transactions were checks," says Bedi. "While electronic payments have grown by more than 50% a year, over half of all transaction volume remains checks, which creates check-clearing obstacles. You're collecting tiny amounts of cash or checks in remote areas where there are only local bank branches that can take weeks to clear them."

"Only 13% of Indians have debit cards," says Ford's Schloss. "A large portion of the population is still rural, compelling banks to expand in the villages. India's Finance Ministry recently asked banks to prepare a blueprint on their plans to reach villages with populations of 2,000 people and more."

Harding says a key problem for treasurers of multinationals is getting currency out of the country. "The currency controls are overly tight, and the central bank has to improve all outflows," he explains. "You have to have all these documents to achieve approval. The onus is on the government and the banking sector to streamline the rules."

Another challenge is liquidity management. Bhushan Tinekar, deputy general manager of treasury at Vodafone Essar, a large provider of mobile communications services in India, and part of the Vodafone Group, says cash management is virtually on par with the West, but liquidity management is a "problem."

He cites the disallowance of notional pooling, the mechanism for calculating interest on the combined credit and debit balances of accounts. "Companies like ours, with a decentralized organization comprising multiple legal entities in India, are unable to do notional pooling," Tinekar says. "Companies can only do actual pooling of monies within each legal entity. Money transfers between legal entities have to be manual and are governed by tax and other regulations."

Shah of Deutsche Bank, Vodafone Essar's banker, agrees that ever-expanding domestic consumption for products and services is not only an opportunity but also a challenge from a treasurer's perspective. "Treasurers in India are extremely keen to get tailor-made transaction banking solutions which aid collections and payments at remote locations across the country to facilitate their business growth while managing the liquidity risk efficiently," he explains.

Despite these challenges, observers are sanguine that India offers a vibrant market with ever-decreasing obstacles.

"Now that the large Indian companies like Wipro, Infosys and the big oil companies are increasingly global, it puts the onus on the Indian government to treat foreign entities more fairly and consistently," says Citibank's Simpson. "This creates opportunities for all multinationals and for financial institutions, as well."

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